Capital tax competition under a common currency

Abstract

We re-examine the view that capital taxes are too low when capital is mobile across tax jurisdictions. We do so by emphasising a previously neglected implication of decentralised capital tax setting when jurisdictions share a common currency. Namely, capital taxes give rise to a vertical externality by affecting the revenues of the over-arching central bank from issuing the common currency. This externality may lead, ceteris paribus, to too high regional capital taxes, and may more than offset the usual effects of tax competition. In this case, and contrary to conventional wisdom, decentralised capital taxes will be too high.